BAML: Spread compression set to continue

Structured finance analysts see further spread compression as inflows into credit funds surpass equity for once.

Spread compression continues unabated amid a market starved for supply and an acceleration of flows into credit funds, analysts at Bank of America Merrill Lynch (BAML) have observed.

“Nothing seems likely to disrupt this market trend in the near term,” structured finance and covered bond analysts said in a weekly BofA Merrill Lynch Global Research (BAML) report.

Most of the new issuance structured finance deals priced this year were upsized, they said, but they lamented the scarcity of mezzanine tranches citing that this would “indicate a true securitisation market recovery not only for funding but also for risk management purposes and would confirm risk discerning investors are on the rise.”

The analysts hinted at a securitisation recovery supporter outside of the industry itself in ECB president Mario Draghi after he said, “capital charges discriminate against ABS versus other instruments.” However, Draghi did say it was up to the Basel Committee and the European Commission to change the regulations.

The analysts noted the acceleration in the UK Funding for Lending scheme and its negative effect on the UK RMBS and SME ABS new issuance market. Outstanding draws are nearly £42 billion – nearly double the 3Q 2013 outstanding figure of £23 billion.

“Compared with the nearly non-existent UK RMBS and SME ABS issuance in the last twelve months, we now have evidence that the FLS scheme is working to the detriment of the UK securitization market,” the analysts said.

The background for the fixed income markets remain positive however, they said, with research from the banks credit strategists suggesting that a ‘reverse rotation’ or a great rotation into credit is taking place.

“Our credit strategists maintain a positive outlook on European credit with 1.5-2 percent return for HG and 3-3.5 percent for HY forecast in 2014,” they said.

In a recent report, the credit strategists said inflows into credit funds in Europe were “very strong” over the last week of February and in one case hit a 37 week high. In contrast, “equity inflows halved week-over-week,” they said.

“The need for yield again resembles the rush seen in late 2012. As a result, combined inflows into credit funds over the last week surpassed inflows into equity funds,” which is a “rare occurrence,” the strategists said.

“For now it’s certainly the year of credit,” they added, despite predicting that 2014 might end up the year of equities for retail investors.